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What Are "Inversions," and Why Should You Care?

"Inversion" is a word for a particular kind of corporate merger deal -- and a word you might be seeing a lot in news headlines lately. It's not the most intuitive name for a corporate tax loophole, so we're going to break it down for you.

Today, President Obama is heading to Los Angeles Trade Technical College, where he's calling for a kind of "economic patriotism" that's based on investing in the things that we know grow the economy for everyone (like education and job training) — not protecting wasteful loopholes for a few at the top.

And he's calling attention to one kind of corporate merger deal in particular — called an "inversion" — a word you might be seeing in a lot of news headlines lately.

It's not the most intuitive name for a corporate tax loophole, so we're going to break it down for you.

Q: So what exactly is an "inversion"?

A corporate "inversion" is what happens when a U.S.-based multinational with operations in other countries restructures itself so that the U.S. "parent" is replaced by a foreign corporation — and usually one that's in a country with a lower tax rate than the United States. As a result, on the whole, this means that corporate income tax that would otherwise be paid to the United States ends up going overseas.

In other words, right now, our tax code allows any American company to merge with a foreign company (so long as that company’s shareholders own 20% of the combined firm) — and then “relocate” or “invert” to another country for tax purposes. This maneuver — which changes nothing about the actual operations that continue in the U.S. — allows companies to dramatically reduce the taxes they owe in the U.S. by taking advantage of loopholes in our tax system.

Meanwhile, they would continue enjoying the benefits and protections of the American economy — provided by our tax dollars. It's a big loophole — and right now, it’s completely legal.

Q: That's got to be costing us a lot of money, right?

Yes, and it could cost us even more. This is a growing trend among American corporations, and they're getting increasingly creative and brazen in the ways they're doing it. What’s more, for decades, countries have been holding "tax competitions" to lure American companies, offering special tax breaks to help them avoid paying their fair share at home.

All told, estimates suggest that it could cost nearly $20 billion over the next 10 years.

Q: OK, but I'm not a corporation. So how does this relate to me?

Simply put: You're paying for it.

That's because when corporations pay less, other working Americans have to pay more to help fund the services we all rely on: rebuilding our roads and bridges, equipping our schools with the resources they need, and defending our country at home.

Most Americans don't have fancy accounting tricks at their disposal — and these businesses shouldn't, either.

Q: So what are we doing about it?

The President's FY 2015 Budget proposes that we do away with these loopholes, ensuring that American companies pay taxes to the country that made them great. And we could take the billions we'd save and put it toward rebuilding our infrastructure in this country — investing in a long-term plan to make sure our roads, bridges, ports, and railroads can support the demands of a 21st-century economy.

Right now, there are proposals before Congress that would do just that.

That's why the President is speaking today — and it's why this explainer blog exists in the first place.